I've been thinking/reading about 529s for some time and I have not yet pulled the trigger. I'm concerned about the flexibility of the account. Let's say I put a bunch of money in there and my child doesn't use it all. Can I get that money back *without a penalty*? I don't think so. What if she doesn't go to college at all? Again, can I get my money back without a penalty?

I'm being theoretical at this point, but it's enough to give me significant pause. Anyone else have these concerns? Can anyone enlighten me if my thinking is incorrect? And if my thinking is NOT incorrect, why would it still be worth it to me?

I've been thinking/reading about 529s for some time and I have not yet pulled the trigger. I'm concerned about the flexibility of the account. Let's say I put a bunch of money in there and my child doesn't use it all. Can I get that money back *without a penalty*? I don't think so. What if she doesn't go to college at all? Again, can I get my money back without a penalty?

I'm being theoretical at this point, but it's enough to give me significant pause. Anyone else have these concerns? Can anyone enlighten me if my thinking is incorrect? And if my thinking is NOT incorrect, why would it still be worth it to me?

When I first began looking at the 529 plans, I had similar concerns that you are expressing here. With that said, I am now investing in a 529 for both of my boys and here are the answers to your questions.

If you invest in a 529 plan and your child chooses not to attend college, you have a few options. One option is that you can change the beneficiary to another family member. If there are no other family members that would need the funds for education, another option is to withdraw the money from the plan.

If you withdraw the money, the contributions that you made are not penalized or taxed. For example, over the years you contribute $50,000 to the 529 plan. If you decide to withdraw the funds, you can take the full $50,000 without penalty or tax consequences. Note, there is the possibility of tax consequences if your state allows deductions from state taxes.

However, any earnings within the account will be assessed a 10% penalty and will be subject to income taxes at your current tax rate. There are some instances where the 10% penalty is not applied and those include the death of the beneficiary, the beneficiary becomes disabled or the beneficiary receives a scholarship.

With that summary, here is a fantastic site with the answers to most of these questions:

I've been thinking/reading about 529s for some time and I have not yet pulled the trigger. I'm concerned about the flexibility of the account. Let's say I put a bunch of money in there and my child doesn't use it all. Can I get that money back *without a penalty*?

Nope. But one point of the account is to avoid or reduce taxes. You can't realistically expect to stash money in a tax-sheltered account and then get it out without a penalty.

What if she doesn't go to college at all? Again, can I get my money back without a penalty?

The government can't possibly get that involved in a family's internal decision-making process -- and I don't think we want it to! So again, the answer is no. You have to work these decisions out for yourself.

Anyone else have these concerns?

Actually, my biggest concern about 529 plans would be that most of them SUCK as investment tools. Most of them allow only a superficial level of "control" over the way the money is invested. It varies from state to state but the investment vehicles involved usually range from average to terrible, and the expenses are often high.

The topic has made the front page of business sections in major newspapers, and is rather a scandal. Some states are not even certain of their plans' future solvency.

As for withdrawals, the Coverdell (Education IRA) is more flexible because -- if I'm not mistaken -- it can be used for education *before* college, e.g. private high school or whatever. But double check that, I'm not sure about it. Otherwise, it has similar issues regarding non-educational use. The biggest plus is that you manage every dollar of the account, and you'd have to be a dunce to underperform most 529s.

But another plan is to put the maximum into your own IRA, because I believe you can withdraw without penalty from your IRA to help fund college tuition. You can't put as much into an IRA, of course, but at least you've got the money socked away either for yourself or the kid, or whatever comes along. If the kid doesn't go to school, you retire a little more comfortably.

Finally, there are UTMA/UGMA accounts, which are no doubt discussed on this board from time to time. The money put into such accounts becomes the child's property irrevocably at the age of majority -- but it does not have to be used for college. Of course, it can be squandered on silly stuff if your child chooses to, but that's another topic entirely. <g> There are slight tax advantages in the meantime, but no total escape from taxation.

Can anyone enlighten me if my thinking is incorrect? And if my thinking is NOT incorrect, why would it still be worth it to me?

AFAIK, the biggest advantage of the better 529 plans is that any gains are deductible both at the state and the federal level (if you're lucky to be in a state with a good one!) The other advantage is that the money in a 529 is treated differently when schools look at your collective assets to determine financial aid eligibility.

I jumped in to reply to your question without checking the history of previous messages -- big faux pas on the Fool -- so my apologies if I am retreading old ground for regulars on this board. Anyway, I hope this helps!

Nope. But one point of the account is to avoid or reduce taxes. You can't realistically expect to stash money in a tax-sheltered account and then get it out without a penalty.

See my previous response to that question because this is not completely accurate. Contributions can be removed without penalty but the earnings will have a penalty unless certain conditions are met.

AFAIK, the biggest advantage of the better 529 plans is that any gains are deductible both at the state and the federal level (if you're lucky to be in a state with a good one!) The other advantage is that the money in a 529 is treated differently when schools look at your collective assets to determine financial aid eligibility.

I think you are overlooking one of the biggest benefits of the 529 plan and that is the much larger limit for contributions. Unfortunately, a Coverdell alone will not provide enough funds to pay for college expenses in my opinion. If that is your only savings vehicle, there will be a need for student loans and/or other means of savings.

As you mentioned, it is possible to use your own IRA to provide funds for college expenses but I personally do not care for this option. This is robbing your own retirement to pay for college. Those funds cannot be replenished to the IRA once they are removed either. In my opinion, this should be a last resource for college funds.

I think the ideal college savings plan would have a combination of plans, such as a Coverdell and 529. That is my opinion.

See my previous response to that question because this is not completely accurate. Contributions can be removed without penalty but the earnings will have a penalty unless certain conditions are met.

I already read your reply and I deliberately left my response simpler. The original question was NOT "Can I get my money back if my child dies or gets a scholarship?" It was about penalties for flat-out withdrawals in case the child chooses a different path other than college. So, these other conditional elements simply cloud the issue.

I think you are overlooking one of the biggest benefits of the 529 plan and that is the much larger limit for contributions. Unfortunately, a Coverdell alone will not provide enough funds to pay for college expenses in my opinion. If that is your only savings vehicle, there will be a need for student loans and/or other means of savings.

No, this is an apples-to-oranges comparison and therefore misleading.

A Coverdell account is self-directed. But I have found not a single 529 plan in which the investment options are that wide open. In some cases, the plan offers a handful of mutual funds from the bottom of the pack from a company you might otherwise never consider.

One might think that the Vanguard-operated 529 plans are "ideal," but in fact, they have their limits as well. One does not get access to every fund in the Vanguard product line! Again, there is a limited menu of funds, typically all indexes of one kind or another, and they may not include styles or sectors that the parent sees as being strong growth areas at different times. Too bad. You are stuck with whatever the fund company worked out with the politicians at that particular state.

Also, there are no real limits to the amount that can go into a child's UGMA/UTMA account -- and it, too, is self-directed by the custodian, rather than being shoehorned into a prefabricated plan put together by an investment firm somewhere. IMHO, the tax benefits of a typical 529 plan are quickly gobbled up by its performance deficit compared to the better mutual funds out there.

I think a combination of Coverdell, parents' IRA, and UGMA/UTMA would cover most people, but more to the point, it *addresses the concerns that started this thread*. Meanwhile, let's not forget the possibility that the child might well earn money along the way. If so, he/she can also begin a conventional IRA in addition to the parent-funded Coverdell.

I had not intended to get this detailed, but the bottom line is that there is a lot of creative financing possible, and most of it yields better results than most 529 plans.

The size of the annual investment is an issue that can be dealt with in other ways. But putting $10,000 into a mutual fund that might decrease in value, or grossly underperform the market, is not exactly a great plan, in my view.

Let's just cut to the chase: you can invest money in ANY account, manage it for maximum return, pay the taxes as you go, and whether you use it for college or not, there are no tax consequences to worry about later on. No annual limits, no arbitrary plans to squeeze into, etc.

The typical 529 does not offer enough benefits to outweigh all that freedom, or all that opportunity for higher yield, in my view.

As you mentioned, it is possible to use your own IRA to provide funds for college expenses but I personally do not care for this option. This is robbing your own retirement to pay for college.

But again, you missed the point of the original person's question! The issue was how to invest for college without making a commitment, in other words, how to put money away but still have access to it in case the child does not go to college. Well, my suggestion addresses that.

Sure, it would be preferable to have other options, but if the parent is unsure where the kid is going, then the parent's IRA is a source of money that 1) can be withdrawn without penalty for educational use, BUT 2) is not by definition *committed* to educational use.

The best solution is to badger Congress into expanding the Coverdell limits, and there is talk in Washington of those various types of tax-sheltered savings accounts that may apply to college funding, if they ever come into existence at all. But for now, given the nature of the orginal question, one has limited choices.

I cited the IRA example because not everybody is using IRAs as their sole retirement vehicle. People with pensions, annuities and 401K plans may not be relying on the personal IRA for retirement. Using it to augment the Coverdell limit means that one could be putting away $4000-5000 per year in tax deferred, self-directed investments for 20 years -- and using only as much as needed.

Those funds cannot be replenished to the IRA once they are removed either.

Sure they can, they just can't be replenished in the tax year they were originally contributed. If a person is 50 when the child finishes college, then he/she has another 15-20 years to rebuild the IRA, and they can do so at a faster clip.

By the way, there is no reason to assume that the account would be emptied completely by the college thing -- it really depends on how well the person has managed the IRA before that, and how much money went into it to begin with. But that's too detailed for this thread, I think.

I think the ideal college savings plan would have a combination of plans, such as a Coverdell and 529. That is my opinion.

You're entitled to your opinion -- but I don't think it's pertinent to the original poster's question, which was all about whether 529 money can be withdrawn without penalty. I think the questioner meant: "Can I get the money out and do something else with it if the kid doesn't want to go to college?"

So, if I'm reading this correctly, it is not answering that question to list all the arcane conditions for withdrawal whereby no penalty is incurred. The scenario the questioner posited *does* involve a penalty.

As for what the best strategy is for college savings... Well, a prepaid tuition plan that might go bankrupt in 10 years would be a bad one. <g> A 529 plan that puts parents' money into bottom-tier mutual funds from a humdrum fund manager does not sound great, either.

Also, the typical structure of many 529 plans is to overweight in stocks in the early years and move to bonds at later ages. Well, that would have been bad news for a kid who was 2 last year or a kid who turned 17 this year. "Market timing" is anathema to some investors but it is a reality for maximizing returns, by allowing one to allocate assets to those classes performing best at the time.

I mean, many 529 plans arbitrarily start moving a child's money from stocks into bonds simply based on his/her age, regardless of the possibility that this might happen to coincide with the start of a major bull market for equities (remember, this is hypothetical!) In a self-directed account, you can still make the shift toward bonds if you want, but you can also tinker with the balance for maximum return.

This isn't supposed to be a battle over personal tastes or biases. This is supposed to be creative problem solving for a person who asked a question. I offered a variety of other approaches that avoid the weaknesses and limits of a 529 plan; those other approaches may have their own problems (extra work for the investor, possible tax exposure) but they also address the original question about keeping future options open for that money.

Let's review the OP's question: Let's say I put a bunch of money in there and my child doesn't use it all. Can I get that money back *without a penalty*? I don't think so. What if she doesn't go to college at all? Again, can I get my money back without a penalty?

Your response was the following, Nope. But one point of the account is to avoid or reduce taxes. You can't realistically expect to stash money in a tax-sheltered account and then get it out without a penalty.

That is not accurate. Any money that a person contributes to a 529 plan can be removed without penalty. So, if the OP's child does not go to college, there is the option to remove 100% of the original principal without penalty. The OP loses no money, assuming the funds in the plan have not lost value.

In addition, the person can remove 90% of the earnings unless the previously defined conditions are satisfied. The only penalty that applies is on the earnings within the 529 plan and not the original contributions.

With that said, I think you make a lot of valid points regarding the other options available for college savings and have provided the OP with plenty of things to consider.

Any money that a person contributes to a 529 plan can be removed without penalty. So, if the OP's child does not go to college, there is the option to remove 100% of the original principal without penalty.

This makes it sound like the investor gets a free ride, but that's not true. The dollar amount one invests as principal will have dropped in actual value, due to inflation, over the 10 or more years typical of a college savings plan. Unless we hit an economic disaster of deflation, the inflation-adjusted value will easily be at least 10% lower than the face value.

And let's not blow off the earnings so quickly -- the chance to grow the money is the only reason to put the money anywhere other than a mattress! Over 10-15 years, with compounding, the earnings should be worth far more than the original principal. That means the majority of the account is, indeed, subject to the penalty.

That is why I do not understand your repeated attempts to make the 529 sound like the penalties are small, when they are not. A withdrawal of the earnings is hit not only with that 10% penalty fee, but also with taxes! So, assuming that the plan actually works well enough to grow the investor's money, I think the correct answer to the question is that one should not stash money in a 529 if one foresees a strong possibility of needing the money for some other purpose.

I say: figure out what approach will make the most money, with taxes taken into account, and go with it. A UGMA/UTMA account can address most of the issues raised by the original question. The personal IRA also does so. Both offer some tax advantages, both can be self-directed by the investor, and both can be used for non-educational purposes.

Let's face it: even a regular, taxable investment account might make the most sense for this person. If the investor makes good decisions and grows the money successfully, and pays taxes along the way, it can result in a nice nest egg that can be used for any purpose under the sun.

But ultimately, a parent has to make certain sacrifices for a child. If it means a less cushy retirement (or a later retirement), then so be it. It sounds like everybody is looking for a free lunch but it's not out there.

This makes it sound like the investor gets a free ride, but that's not true. The dollar amount one invests as principal will have dropped in actual value, due to inflation, over the 10 or more years typical of a college savings plan. Unless we hit an economic disaster of deflation, the inflation-adjusted value will easily be at least 10% lower than the face value.

I think you are over-exaggerating the issue of deflation but I agree that it does have an impact. This was not something I was factoring into the equation and seemed to be more information than the OP was looking for. Also, I would be interested to see how you came to the conclusion that the inflation-adjusted value will easily be 10% lower than face value. Are you assuming a lump sum contribution or continuous contributions over time?

And let's not blow off the earnings so quickly -- the chance to grow the money is the only reason to put the money anywhere other than a mattress! Over 10-15 years, with compounding, the earnings should be worth far more than the original principal. That means the majority of the account is, indeed, subject to the penalty.

I am not blowing off the earnings. I have clearly stated the earnings will carry a penalty under most circumstances. However, the OP seemed to be more concerned with losing their original contributions. Many people have the thought that if the funds are not used for college expenses, they will lose the money that they contributed. And that is not the case.

That is why I do not understand your repeated attempts to make the 529 sound like the penalties are small, when they are not. A withdrawal of the earnings is hit not only with that 10% penalty fee, but also with taxes!

I am not attempting to make the penalties seem small. And as you will notice in my first response, I indicated that the earnings will be assessed a 10% penalty and be treated as regular income in most circumstances. I am just trying to provide the facts to the OP and allow them to make their own decision as to what will work for them.

So, assuming that the plan actually works well enough to grow the investor's money, I think the correct answer to the question is that one should not stash money in a 529 if one foresees a strong possibility of needing the money for some other purpose.

I certainly agree with this and this can only be answered by the person in question. We have no idea how strongly the OP feels that their child may not use all of the funds invested in the plan or that their child may not go to college at all. If the OP has a very strong feeling that the child may not go to college, then you are absolutely correct that the 529 is not the best option. However, if these doubts are caused more by not understanding how the 529 plan works under different situations (as they were in my case), then they need to be informed of the provisions of a 529 plan and make their own decision.

I say: figure out what approach will make the most money, with taxes taken into account, and go with it. A UGMA/UTMA account can address most of the issues raised by the original question. The personal IRA also does so. Both offer some tax advantages, both can be self-directed by the investor, and both can be used for non-educational purposes.

Correct. There is no cookie-cutter approach to saving for college expenses and it can vary significantly depending on personal circumstances. When considering a UGMA/UTMA, the person needs to be made completely aware of the possibility that the child will gain control of that money at the age of majority and can elect to blow those funds on anything they desire. I know you mentioned that in a previous post but I feel it bears repeating. One would hope that you have done a solid job of parenting to that point where the child will not blow that money. But when an 18 year old teenager realizes they have $x dollars at their disposal, they may make some bad decisions and there is nothing you can do about it.

Let's face it: even a regular, taxable investment account might make the most sense for this person. If the investor makes good decisions and grows the money successfully, and pays taxes along the way, it can result in a nice nest egg that can be used for any purpose under the sun.

Wouldn't this depend on the tax bracket? With a 529 plan, distributions to pay for college expenses are free from federal taxes. However, with a taxable account, there could be siginificant tax consequences to take a distribution for the college expenses.

But ultimately, a parent has to make certain sacrifices for a child. If it means a less cushy retirement (or a later retirement), then so be it. It sounds like everybody is looking for a free lunch but it's not out there.

That is very true, however funding a child's college education does not have to result in a less cushy retirement or a later retirement. If you LBYM as a lifestyle and watch your expenses, it is certainly possible to fully fund retirement accounts and college savings.

I really appreciate your feedback on alternative methods of saving for college expenses. I assume that you have children or are saving for collge as well. If so, do you mind sharing what your strategy is and why you opted to go that route? It is apparent you have put a lot of thought into this.

There is no cookie-cutter approach to saving for college expenses and it can vary significantly depending on personal circumstances.

This is something that seems to have been lost in the discussion.

In my own case, the staggering amount to be saved ($140k by my estimates) made a 529 plan the best choice. I'm not expecting any financial aid. I'm assuming 5% inflation on tuition, and some folks think that's conservative.

To make blanket assertions that "this sucks" or "that's best", in my opinion, are overly simplistic.

I think you've summarized the original question perhaps more accurately than I had been doing -- I do recall the poster emphasizing "getting out the money that I put in" more than anything else. Of course, this suggests that the poster had not though through these other issues that you and I have been discussing -- particularly, the notion that the goal of the plan is to grow those contributions into something larger!

"Let's face it: even a regular, taxable investment account might make the most sense for this person. If the investor makes good decisions and grows the money successfully, and pays taxes along the way, it can result in a nice nest egg that can be used for any purpose under the sun."

Wouldn't this depend on the tax bracket? With a 529 plan, distributions to pay for college expenses are free from federal taxes. However, with a taxable account, there could be siginificant tax consequences to take a distribution for the college expenses.

It would depend not just on the tax bracket, but more so on the savvy of the investor. This was a hypothetical situation -- indicated by my having posited the condition "If the investor makes good decisions..."

What I'm thinking about is the option of any investor to play the stock market, buy and sell options, buy on margin, etc. etc. -- these are not techniques that I claim to be good at but there are surely some people who could do well enough at it to clobber the modest growth expectations of most state-run plans.

(And of course, this type of aggressive investing simply is not feasible in a 529 -- and I wouldn't think it prudent within a Coverdell, either).

But let's say you take $10,000 and put it away in a plan that yields 6% a year for the next 10 years, and get the results tax-free. OR you take $10,000 and manage to earn 10% a year (NET, after taxes) for the next 10 years. Without doing the math (yes I'm lazy!), I assume that the second scenario yields a larger nest egg. There will be few tax consequences at the time of use because most taxes were already paid along the way. If there were any LTBH investments in there, then there would be a LT cap gains tax -- the rate of which does not depend on tax bracket, IIRC.

Again, this is more specific than I wanted to get. I just wanted to say that the 529 plan is still new and still evolving and that most of what I've seen was not very encouraging. A truly self-directed plan could help the investor avoid disaster in the current bond market frenzy, or the losses that would have come from being locked into a broad index fund from about 2000 through 2002. An individual investor could have avoided getting stuck in foreign funds -- indexed or otherwise -- that followed Japan through its long period of trouble, whereas some 529 plans no doubt had "foreign funds" with positions in Japanese stocks. And so on. One doesn't have to look very far to see better returns than most state-run plans offer.

Oh, and that's another thing -- getting accurate data about the performance of some plans is REALLY hard. Talk about challenging research. When one sees data that is hidden that carefully, it naturally makes one suspicious.

...do you mind sharing what your strategy is and why you opted to go that route? It is apparent you have put a lot of thought into this.

Yes, I've researched this topic quite a bit, but I do not discuss much about my personal life on TMF or any public forum. I don't want to seem rude by not answering; I will simply say that I was curious about these issues, and there were people in my immediate acquaintance who could benefit from my research. Beyond that I can't be more specific.

The strategy I outlined before -- using every other investment tool BUT a 529 plan -- is essentially the path I would choose. If I were a parent who wanted to put away a ton of money all at once, well I'd have to consider a 529 due to the size issue, and in that case I'd pick very carefully from among the Vanguard-related plans -- but I would surely hedge my bets with the other tools.

And in the case of a parent of more limited means -- I simply think that the Coverdell makes a lot of sense. The investment minimums are set at IRA levels for mutual funds, and so on.

I also think the parent should think in terms of getting through the first year, perhaps two -- but not plan on having four years' worth of Harvard tuition available. Over a 10-15 year time frame, so much can happen... so as the child gets closer to that age, it will be more obvious whether he/she will qualify for scholarships, or loans, or whatever.

And there is always the old standby of "working one's way through college" -- with the proceeds of a small investment account being very helpful, even if they aren't enough to give the kid a totally free ride.

Even earlier: summer jobs, paper routes, baby-sitting and lawn-mowing can add up... and if declared, that's earned income. (Locally, kids can get $10 and up per hour of babysitting, and $20 or more apiece for shoveling sidewalks). Well, $40 a week is $2000 a year. The child can have his/her own IRA at any age, and the deposits to it can come from anywhere as long as the total doesn't exceed the earned income. So the child can spend some of the money earned (let the kid have SOME fun!) and the parent can contribute to the child's IRA, thus rising past the limits of the Coverdell and still getting a tax sheltered account.

Granted, many of those jobs would come as the child got pretty close to college age, but you could still be looking at $6-10,000 added to the pot, with time to grow at least a little (there's no rule saying that you must begin withdrawing immediately at age 18). It could be enough for a full year of tuition at some cheaper schools, for instance. Every little bit helps.

There are a lot of rules about IRAs so I do not want to exceed my expertise here. But I suspect many parents have overlooked the notion that the child can help create his/her own asset base early on. And obviously the same ideas do not apply to all children or parents.

There's just a lot of creativity being left by the wayside, while brokers, investment companies, states and others seem very eager to get their hands into parents' wallets. I've seen a lot of glib and deceptive marketing for plans that I knew were stinko, and that's enough to get my dander up. As for websites with 4 and 5 cap ratings... Well, I trust that about as much as I trust Morningstar "star" ratings and so on. Nothing so complex can be reduced to a single number like that!

One really needs to do more research, and unfortunately it's very tedious, very time-consuming, and most parents probably don't have time to do it. So for all my kvetching about it, one can see why a parent would be attracted to something that had the catchy name "college savings plan" and vague language about tax advantages. They won't have time or energy to dig deeper and find out that the ROI on that plan might be pitifully low.

Since many mutual funds allow IRA buy-ins at $1000 or less, it seems to me that two years' worth of Coverdell would let you get a portfolio diversified into 3 or 4 carefully chosen funds. In some other account, whether UTMA/UGMA or standard investment account, you might pick a few stocks, or some more aggressive mutual funds, or whatever. How much you put away is up to your own limits. Just do the standard thing of making sure to cover most of the available asset classes, and rebalance across all those accounts as economic factors change.

Whether you use your own IRA, or have the kid establish one, or any of that... it's up to the parent's level of energy and time available, I guess. Speaking of time, I'm a bit overextended myself so that'll have to do for a reply. Hope it helps. :-)

In my own case, the staggering amount to be saved ($140k by my estimates) made a 529 plan the best choice.

I think you may have lost the point I made, within all the words flying by. My contention is that 529 plans do not necessarily yield the best return on the parents' investment, regardless of tax concerns.

As for the "staggering amount" -- a lot depends on the rate of return between Point A and Point B. If you were to get only 5% per annum on your 529 investment, then by your own estimation, you will actually have to invest the entire $140K out of pocket.

It seems to me that if a parent has a few years to work with, he/she should find something with a better rate of return (and some degree of reliability) and let the magic of compounding go to work. If we are all very, very lucky, that could happen with broad market index funds as we go through an economic recovery in the next 10 years.

Or we could watch the government give more money away every year, and continue to dilute the bond market to try to cover its massive deficits, resulting in the disruption we have now. Just as people lost bunches of money on equities a year or two ago, they're losing it now in bonds. I think the continued outside interference in natural market forces calls for active management of the account by the investor -- moving among asset classes, and investment styles, as circumstances may dictate. But that's not something that 529 plans are designed for.

In my own case, the staggering amount to be saved ($140k by my estimates) made a 529 plan the best choice. I'm not expecting any financial aid. I'm assuming 5% inflation on tuition, and some folks think that's conservative.

To make blanket assertions that "this sucks" or "that's best", in my opinion, are overly simplistic.

It appears that we are in similar situations as my estimates for funding are quite similar to yours and I am not expecting any financial aid either. We are estimating that we will be footing the entire bill for the college expenses.

I have a spreadsheet at home with my calculations but I think we used a bit more aggressive number for the inflation on tuition. If memory serves me correct, I think we estimated at 7% or 8%.

Of course, this suggests that the poster had not though through these other issues that you and I have been discussing -- particularly, the notion that the goal of the plan is to grow those contributions into something larger!

You are absolutely correct. The main reason for investing in a 529 or any other savings vehicle is to earn interest and have it compound nicely!

But let's say you take $10,000 and put it away in a plan that yields 6% a year for the next 10 years, and get the results tax-free. OR you take $10,000 and manage to earn 10% a year (NET, after taxes) for the next 10 years. Without doing the math (yes I'm lazy!), I assume that the second scenario yields a larger nest egg. There will be few tax consequences at the time of use because most taxes were already paid along the way. If there were any LTBH investments in there, then there would be a LT cap gains tax -- the rate of which does not depend on tax bracket, IIRC.

You make some very valid points. My only caution would be to add the note that one should be a savvy investor to undertake this as your only means of savings for college. On the flip side, let's say you could earn that same 6% in the 529 plan but one decides to dabble in the market instead. However, Joe Investor is not as slick as he thought and he winds up losing 10% of the contributions. Investing in individual securities requires a lot of effort and knowledge, and even then nothing is guaranteed. Please note, I fully understand the same risks apply to a managed plan such as a 529 but I am just pointing out the possibility that an investor could make bad decisions while the market (and the managed funds) are doing well.

I also think the parent should think in terms of getting through the first year, perhaps two -- but not plan on having four years' worth of Harvard tuition available. Over a 10-15 year time frame, so much can happen... so as the child gets closer to that age, it will be more obvious whether he/she will qualify for scholarships, or loans, or whatever.

And there is always the old standby of "working one's way through college" -- with the proceeds of a small investment account being very helpful, even if they aren't enough to give the kid a totally free ride.

I think this is really hitting at the heart of the matter. For me personally, my goal is to provide a funding for 4 years worth of college expenses at the institution of my child's selection. If they want additional education beyond that, they are on their own. But that is the goal that we are setting forth with but agree, should our child select somewhere like Harvard, we will most likely not be able to do it.

And if we can help it, we would prefer not to require our children to work through college. I had to do that and I do not regret it, but my goal is to provide the funds so my children do not have to do it. I can look back now and view it as a character building expereience but there were some extremely lean times.

Yes, I've researched this topic quite a bit, but I do not discuss much about my personal life on TMF or any public forum. I don't want to seem rude by not answering; I will simply say that I was curious about these issues, and there were people in my immediate acquaintance who could benefit from my research. Beyond that I can't be more specific.

I do not view that as being rude as well and appreciate your response, as I am sure your acquaintances appreciated your research. And as you have mentioned, it would be nice to have the option to have more control over the investment choices. As time passes and these plans evolve, that may happen.

As for the "staggering amount" -- a lot depends on the rate of return between Point A and Point B. If you were to get only 5% per annum on your 529 investment, then by your own estimation, you will actually have to invest the entire $140K out of pocket.

I have not evaluated the returns of all the available 529 plans but I get the feeling that you are painting the picture to be more grim than it truly is for the ROI in 529 plans.

For example, the plan that we have invested in returned slightly over 17% in the last quarter with close to 15% YTD. That is drastically better than the 5% and 6% that you have been referencing in your posts.

Also, I believe you made a comment about truly determining the ROI within the 529 plans. Could you please elaborate more as I am very interested to hear what you have to say regarding that.

I have not evaluated the returns of all the available 529 plans but I get the feeling that you are painting the picture to be more grim than it truly is for the ROI in 529 plans.

For example, the plan that we have invested in returned slightly over 17% in the last quarter with close to 15% YTD. That is drastically better than the 5% and 6% that you have been referencing in your posts.

I'm citing numbers from people like Warren Buffett and others, who have said recently that they would not expect to see overall market growth at rates anything near those of the late 90s. I can't give you a specific source but I assure you the number was something like 6 or 7 percent. Most other projections I've heard, from people with similar chops to WB, are all single digits for the market as a whole.

If we agree with the consensus that most mutual funds will underperform the total market, that "paints the grim picture" as you put it -- it's not something I'm making up due to a negative demeanor or something.

As for the performance you cite, I am curious whether your funds that did so well in these two specific quarters also did well in the second half of 2002, or even within this year, if they have done as well since June 30 as they did before that. What I'm implying is that all boats go up in a rising tide. What I think a typical parent needs is an investment that can do well throughout the widely varying conditions that we've seen in recent years.

Also, I believe you made a comment about truly determining the ROI within the 529 plans. Could you please elaborate more as I am very interested to hear what you have to say regarding that.

No, I can't -- the research I did was not recent and I'm not motivated to dig tons of data out from wherever it is now. But here's the gist. I found that many plans would describe their holdings in vague terms that made it very hard, or impossible, to identify the specific mutual funds in which one's money would go. Rarest of all was to get the actual tickers. In one case I ran into, funds were not even publicly traded, and I'm not sure whether SEC disclosure rules apply to such entities, but it sure lowered my confidence level.

Also, the balance between specific funds was just as vague. They might say that the plan was "80% stocks" but only a lot of digging would turn up the fact that they were putting a bunch of money into large cap growth funds that were well into the red at the time, while many small cap value funds were doing very well.

Basically, the money was often going into a style of fund that was clearly wrong for the investment environment at the time. And the decision to go with such a dogmatic, predetermined allocation plan guaranteed that the account would lose a lot of value -- value that would be very difficult to make up later -- if the slow-growth scenario predicted by Buffett and others is accurate.

This year, many large cap funds are doing better. But not well enough to make up what they lost last year or the year before, for parents who might have been holding them that long. Maybe in two years they'll be at breakeven -- which means they've lost 3, 4 or 5 years of investment opportunity with that cash.

That's the big issue, seems to me. The kid does not stop getting older just because the market is slow, or because a particular 529 plan has an arbitrary and dopey arrangement whereby (for example) growth funds get most of one's money despite the fact that the economy might be in a period of consolidation and slow growth, or even contraction.

So my beefs are numerous, including but not limited to: failure to disclose the actual investment vehicles, either by name or by portfolio weight; overly limited choices of investment styles (e.g. no mid-cap value funds, or no REIT funds, or whatever); bad performance of the funds offered (anything below the top quartile, at least); lack of flexibility for the investor to change the allocation with some reasonable frequency (e.g., once per quarter at least); and so on.

Despite the apparent secrecy, I was able to find out enough about the performance and/or ratings, of enough of the funds, in enough different state plans, to make me tired of the quest. I don't think I looked at all those that offered investment style plans, but I sure looked at a lot, and it left me where I am now.

Anyway: if you have a 529 plan that has shown double digit growth over the past 12 months, 3 years, and 5 years, then spill the beans and tell us what it is!

I'm citing numbers from people like Warren Buffett and others, who have said recently that they would not expect to see overall market growth at rates anything near those of the late 90s. I can't give you a specific source but I assure you the number was something like 6 or 7 percent. Most other projections I've heard, from people with similar chops to WB, are all single digits for the market as a whole.

Understood. Personally, I have been using an 8% return in most of my retirement and college savings calculations but even that might be a little agressive. I would tend to agree that the days of the 10% average return may be gone. However, if the entire market is only returning 7% or 8%, is 6% or 7% in a 529 really that bad?

If we agree with the consensus that most mutual funds will underperform the total market, that "paints the grim picture" as you put it -- it's not something I'm making up due to a negative demeanor or something.

My investing style lately has been one of index funds, which track the market and return comparable numbers. I am seeing similar performance from many of the 529 plans. In my opinion, the level of required effort and risk is not worth the extra 2-3% I may gain over index funds.

As for the performance you cite, I am curious whether your funds that did so well in these two specific quarters also did well in the second half of 2002, or even within this year, if they have done as well since June 30 as they did before that. What I'm implying is that all boats go up in a rising tide. What I think a typical parent needs is an investment that can do well throughout the widely varying conditions that we've seen in recent years.

No, the funds did not do as well in the second half of 2002. However, the funds did follow the trends in the market. And over the long-term that I am investing for my kids college expenses, I expect there to be some fluctuations in the performance of my funds.

Maybe that style is not for you but I have found index funds to be just right for me. I am perfectly happy with my funds performing inline with the market. I am not trying to beat the market, as in my experience that is a losing proposition.

Anyway: if you have a 529 plan that has shown double digit growth over the past 12 months, 3 years, and 5 years, then spill the beans and tell us what it is!

I wish that was the case but it is not. As I mentioned earlier, the numbers were not as good last year so I have not stumbled upon some magical fund. :-)

I would tend to agree that the days of the 10% average return may be gone. However, if the entire market is only returning 7% or 8%, is 6% or 7% in a 529 really that bad?

Yes, if the rate of tuition inflation is 5%, as was suggested in another message. I won't add the rate of monetary inflation -- presumably the tuition inflation was expressed in current dollars. If not, then one needs to deduct another 1% per annum as well.

IOW -- if all those assumptions are correct, or at least in the ballpark, then the growth of $10,000 at 7% probably will result in only $10,000 worth of equivalent tuition in 2003 dollars -- possibly a little more, but not much.

Sure, this is disheartening but so is most of the economy at the moment. Anyway, just "keeping pace" with the stock market may not be the best strategy for growing a college investment. In the past two years, trillions of dollars exited the market. Much of that money went into real estate.

So a person in 2000 -- equipped with a crystal ball <g> -- should have purchased a house and/or a rental property, since in most cases it would have resulted in a better and more predictable ROI than any other investment. Even if housing prices plateau or recede a bit (as some people predict), they won't go all the way back to 2000 price levels, and eventually they will begin inflating again.

I personally do not care (for the moment) about how that idea fits in with the tax implications for colleges and so on. What I care about is the maximum return for the dollar, after taxes and other expenses are netted out.

My investing style lately has been one of index funds, which track the market and return comparable numbers. I am seeing similar performance from many of the 529 plans. In my opinion, the level of required effort and risk is not worth the extra 2-3% I may gain over index funds.

I would aim higher than a 2-3% advantage. Beyond that I'd also want to reduce overall volatility, because it reduces one's gains, too. The problem with indexes is that one has to assume that the old wisdom will hold true for the next 30 years as it did the last 30 years. Well, bonds are now behaving in ways that they have not behaved in over 30 years. The stock market has other pressures and characteristics that did not exist even 5 or 10 years ago.

So I would be hedged out the wazoo, in multiple asset classes, multiple styles, and so on. And I'd be watching like a hawk and reading the tea leaves, because each new day brings influences and phenomena to the world of investing that most of us have not seen before. I think that undercuts the validity of the "efficient market" concept, which is why I would rather have help from savvy fund managers, rather than trusting the people at S&P to put good stocks into the 500 index every year, and then just going along passively for the ride.

No, the funds did not do as well in the second half of 2002. However, the funds did follow the trends in the market.

Well, the trends have not been our friends, to contradict the old saw. Over the past 5 years, the S&P has actually lost money. Will it regain its old form and bounce all the way back? I don't know, but parents who bought index-based 529 plans for 13 year-olds in 1997 are probably not happy about the results they got. It sure takes a leap of faith to expect things to sort themselves out naturally.

Meanwhile, there were some managed no-load mutual funds that went up last year, and over 5 years, and which are still going up this year. Building gain upon gain is more effective than building gain upon loss upon gain upon loss. That is why I have argued in favor of any arrangment that allows for self-directed investing. But if that point is not clear by now, there's no point repeating it.

I wish good luck to all, no matter what path they take. Now, let's see the government do something intelligent about proper funding of quality education BEFORE college! The states are all issuing report cards of "improvements" in their public schools, but the standards vary from state to state. Good grief, what a disorganized mess.

Shouldn't it be a goal that a high school diploma from School X in Missouri is *more or less* equivalent to a high school diploma from School Y in Connecticut? Or that kids entering kindergarten across the country have *more or less* equivalent learning skills and familiarity with numbers and letters? I think it's obscene that these are not high priority goals of society, or of government. Let it go long enough, and we will end up a polarized nation of haves and have-nots, with no common culture.

I mean, if we at least had a country full of kids who had ALL graduated from decent public high schools, we would have a smarter and more flexible labor force and be in a more competitive position in world markets. And those kids would also be better prepared to make the most of their opportunities, if they are able to go to college -- meaning a better education, and a richer life experience.

Well, the trends have not been our friends, to contradict the old saw. Over the past 5 years, the S&P has actually lost money. Will it regain its old form and bounce all the way back? I don't know, but parents who bought index-based 529 plans for 13 year-olds in 1997 are probably not happy about the results they got. It sure takes a leap of faith to expect things to sort themselves out naturally.

As are the parents that opted to do their own investing and plunked their money into companies they thought were solid, such as Enron, MCI, etc. :-)

No, I can't -- the research I did was not recent and I'm not motivated to dig tons of data out from wherever it is now. But here's the gist. I found that many plans would describe their holdings in vague terms that made it very hard, or impossible, to identify the specific mutual funds in which one's money would go. Rarest of all was to get the actual tickers. In one case I ran into, funds were not even publicly traded, and I'm not sure whether SEC disclosure rules apply to such entities, but it sure lowered my confidence level.

Also, the balance between specific funds was just as vague. They might say that the plan was "80% stocks" but only a lot of digging would turn up the fact that they were putting a bunch of money into large cap growth funds that were well into the red at the time, while many small cap value funds were doing very well.

Point taken -- some 529 plans are not very forthcoming on this type of information. I wouldn't invest in them, either.

In picking my plan, one of my considerations was how comfortable I was with the management of the fund. One of my final contenders had money going into funds for no apparent reason. For example, two foreign stock funds. Why? I never did figure that out. They eventually lost out.

The winning plan listed which funds were in which age-based portfolio, and in what percentage. From there I could research past performance and compare results. I didn't need them all to be great -- I only needed one.

Let's add a twist:1. 529 account for junior funded with $10,000 initial money, no more is added over time2. account sits earning 7% annually for 10 years, account now valued at $19,666 (aprox.)3. junior decides no college or approved tech school4. mom and dad pull the plug on the account, receive the initial $10k without penalties5. $9,666 is received less 10% penalty ($967) and taxes at marginal tax rate ($2,610)6. total amount received: $16,090

So, the net gain is about $6k on a $10k 10 year investment, is that good enough?

Further considerations: annual fees for the account, cancellation/closure of account fee, state taxes

So, the net gain is about $6k on a $10k 10 year investment, is that good enough?

Actually, that's not all that great compared to some other investments. I've seen charts for no-load mutual funds that return $4-5K (on a $10K start) within FIVE years. Projecting those same funds out to 10 years would be a pretty hefty number if they were able to sustain it. (Sustaining the same growth for 10 straight years is probably unlikely, but it's the assumption that you made, so I've just borrowed it.)

Anyway, if that hot mutual fund is in a UTMA/UGMA account, the hefty profits are withdrawn and taxed at the child's rate, which would no doubt be pretty low since he/she would presumably be a full-time student and not a wage-earner.

Just playing devil's advocate... :-)

Meanwhile, I think the question has to be asked: why is it that 529 plans aren't simply set up similarly to Coverdell plans? Why is it that the investment firms that team up with states do NOT allow investors to choose from more than a handful of funds, or to change allocations more than once a year?

I realize that the plans have to meet certain criteria to remain tax-exempt. But surely that could be done while allowing investors to choose from (let's say) 30 funds, with none rated lower than 3 stars (Morningstar stars or S&P stars, take your pick) and preferably a lot of 4 and 5 star funds.

Granted, the fund companies would have to agree to a certain amount of flexibility that they might not normally entertain, but in return they'd get a captive market with a big influx of new capital that is unlikely to exit unpredictably.

I'm just brainstorming here, but I can't help noticing how vastly different it is to shop for mutual funds or other investments in a normal brokerage account (which a Coverdell or UGMA/UTMA basically are) -- as compared to the incredible difficulty of shopping for 529 plans and trying to decipher their various different schemes.

Maybe there are good reasons, but I can't help thinking about the fact that many State Treasurers are elected officials, with campaigns that require funding from somewhere, and...

Littlechap,I posted my example to show exactly that the overall potential return is not that great as you pointed out. I agree that there are better alternatives for my family to use such as UGMA/UTMA and the Coverdell IRA, which is what we have done.

My child is fiscally responsible at age 11, and hopefully will retain that responsibility when the age of majority arrives. I am not really worried about my child taking the assets of the custodial account and blowing it on a fast car, cool European vacation etc because if that is the child's choice so be it. Of course there may be consequences such as when the child is ready for college and the money is gone, it is gone and the child will have to utilize other means (loans etc) to secure the funding for education.

I also like the Coverdell IRA because it can be converted (with tax consequences) to a regular IRA at age 30 of the child. This will provide a nice beginning nest egg for a young person who chooses not to go to school, or does not use all of the money.

Dilmatz;I just read the posts on this topic so apologize for being 'late' with info. There is one investment you might consider as part of your college savings. These are 'I-bonds', one type of US government bond.

Here are the advantages that make them attractive as part of your college savings portfolio (one big disadvantage is that they are bonds, so are expected to return less than stock investments over a long period of time. however, they can be a part of your portfolio with stock investments, real estate investment trusts, etc. as the rest of your savings/portfolio to help increase overall return):

* return is part fixed (established during the 6-month window you buy the bond. the government can reset this number each 6 months when new bonds are issued) and part variable, with the variable part correlated to the consumer price index. the variable part helps ensure your return increases if inflation increases (not many bonds offer this!). Current payout is 4.66% for the most recent bonds and higher for those who bought the bonds a few years ago when the fixed portion was higher (which stays the same as long as you hold the bond. I have some with the fixed portion at 3% so my total return right now is about 6.6%, whereas the current fixed portion is 1.1%).

* zero commissions to buy or sell - you can march down to your local bank any time they're open and buy (or presumably sell) these bonds. you'll get face value exactly equal to the dollars you give to the bank (they get no commission on these, nor does anyone else, so don't try to get your broker to sell them, they are not interested and probably can't sell them anyway)

* interest is 'paid' (accrues to the bond using US government 'accounting', no check is sent to you) and compounded semi-annually. there is no current tax due at any time while you hold the bond(s). tax would be due at the time you cash the bond(s) in UNLESS (see next cool advantage)........

* if your income is below a certain level when you cash out the bonds and you use the money for qualifying college expenses (you can find out exact terms by researching I-bonds on www.ussavingsbonds.gov) THERE IS NO TAX! (hey, sounds like a 529 tax-free benefit with no risk that the government might re-neg on the tax-free promise, which currently is scheduled to sunset in 2010, although admittedly no one believes the government would actually re-neg on this promise)

* zero capital risk, meaning the bonds are always valued at exactly face value plus accrued interest (see caveats below). the bonds are not traded in the public market, so there is no up and down price movement even if interest rates change.

* you can hold the bonds up to 30 years, although you must hold for a minimum of one year before you can cash them out. If you cash them out in between 1 year and 5 years, you forego 3 months of your most recent interest (pretty cheap if you really need the money, maybe even less than a fee to take out a loan from a bank). after 5 years, you can let interest accrue or cash them out for full value plus interest at any time with no 3-month interest penalty

* as these are cash-basis bonds, there is no restriction on what you use the money for. you can choose anything you want, but note (repeat from above) that if you use them for qualified college expenses (same definition as 529 plans) AND your income is below the qualifying level, you pay no tax (zip, nada, bupkis, nuttin')

forgot to mention there is a limit per year per social security # (you and your hubby can each buy them) of max $30,000 I-bonds you can buy, but this shouldn't be a limit problem for most people, especially as you can do more each year and quickly get enough to fill out a significant part of a college savings portfolio........

GREAT discussion, guys! I just learned more about 529's than I ever did just surfing the various web pages dedicated to them! I just recently sent off my first check to open a 529 in my home state, NJ, for my son who was born 4 weeks ago. I figure, the minimum investment is $300 per year ($25 per month) and I can change investment classes once per year. Also, an S&P 500 index fund is included in my investment options, so if I don't like the way my plan is being managed, I can always just choose to put all of my investments into it and "let it ride".

Just a bit from my own experiance, when I graduated high school, I didn't really have much ambition to go to college. However, I was presented with a check for $1,700 from my grandfather, who had been saving the money for me for a graduation gift. At around the same time, I was discovering the joys of beer and partying, and, anxious to please my new-found "friends", I wound up spending just about the entire amount on riding around and partying. I still feel regret to this day.

I was not, and am not, an irresposible person. It's just that when you are that young you don't see things in the same way, nor do you necessarily have your priorities straight. I understand and accept that. I also hope to save a good bit more than the $1,700 my grandpop saved for me to give to my son, but the idea of just presenting him with a check for, say, $15K when he graduates gives me some pause, and that is why I like the 529 plan. I still control the money until my son is ready and able to make the best decisions on how to use it.

I may still make use of other savings vehicles, I haven't really looked into them too much as I have been really busy lately, but for right now I like the 529 for the control it gives me.

...the idea of just presenting him with a check for, say, $15K when he graduates gives me some pause, and that is why I like the 529 plan. I still control the money until my son is ready and able to make the best decisions on how to use it.

Two points. The first one is that in some states (like PA) the UTMA does not revert to the child until he/she is 21 years old -- NOT 18. Double check the rules in NJ; that may solve the issue immediately.

Also, as you know, it's the birthday that matters, not the completion of high school. Some kids will finish school well before their 18th birthday, so even in states where 18 is the legal age of ownership, the child may have time to think things over. At this point, the question is what kind of company has the child been keeping. If they are hanging out with total losers in 10th grade, that's a signal! But if their friends are on track toward college, your own kid(s) will probably follow suit.

The other point is that your grandfather probably did not spend 18 years in a concerted effort to shape your value system. But that is what you should be thinking about with your kid(s). In your own case, you do not mention what your parents were doing. One assumes that they probably did not have the means to send you to school, and/or that there was not a history of higher education for them, or previous generations.

And by the time your kid(s) are 18, I think it will be fairly difficult to get any kind of decent work without four more years of school -- and that message will no doubt be drilled into kids' heads if their educators are doing their jobs.

The child's friends and peers also play a huge role. In my day kids identified the kind of track they wanted to follow (business, vocational, technical, college prep, etc.). The child's ability to fit in with the content of the chosen track should help predict whether he/she has chosen appropriate goals.

A child who is in a college prep track will most likely develop friends who are also going to college. There will be peer pressure to take the SATs, apply to good schools, and otherwise do all the things that one does starting at age 16 and sometimes even earlier, as preparation for a college career. If the child is not doing those things, and does not seem to be headed toward college, there is still time for the parent to reconsider the deployment of the money before the child has access to it.

For instance, the parent can invest in other things besides mutual funds, stocks and so on. I've forgotten the details, so you should double check this, but I think the rules say that the parent can spend the money on nearly anything that is reasonably construed as being in the child's interest. That might include buying him/her a hot dog cart, for all I know. People have built financial empires from such humble beginnings.

The point is simply that you need to look at your child(ren) and make sure that *you* are as dedicated to their future education as you expect them to be. I understand what you say about acting irresponsibly even though you didn't consider yourself an irresponsible person. No doubt you learned from the process. Well, you've got a long time to teach your kid(s) the same lessons you learned, and to lead by example. Have faith in yourself and in the values you teach them, and I think everything will fall into place.

One last thought. You probably sell yourself short a bit here. That $1700 was not going to get you through college, and you were probably smart enough to realize that. Very often, when we see a seemingly impossible *longterm* goal, we give up -- rather than taking the first steps toward reaching it. Again, this is a matter of discipline and I do not claim to be an expert at it! <g>

So, your grandfather would have done you a much bigger favor to give you not just the money, but some kind of road map, so you could see how the money could be applied usefully on the road toward something bigger. Otherwise, your youthful mind would correctly recognize that small quantity as being "mad money" and treat it accordingly, as you did. It would be a lot bigger shock to hear that you had squandered $17,000 rather than $1700.

Some folks here have stated very challenging goals, such as having four full years' worth of college expenses for the child, nothing less -- and nothing beyond that, for getting started in a first job or whatever. One obvious problem is that being able to hit that dollar figure precisely is like aiming a rocket today toward an asteroid that has not yet been discovered.

I sense a peer pressure in some of those comments -- like it's a badge of dishonor for a child to "have to" work before, or during, college -- or to contribute to his/her own tuition or living expenses. Speaking from my own experience, I had far more success in educational processes that I funded myself, than in those that were funded for me by others. I've also had a chance to teach college kids and I guarantee that there is a difference in the attitude. Those who are scraping to get by usually value their grades, and do not take as much for granted. So I think there is as much danger in giving the child too much, as there is giving them not enough.

Well, that's a lot of philosophizing. But I honestly think that the goals and value systems you impart over the next 20 years will play a much bigger part in the decisions made by your child(ren) than than the amount of money you can generate into a college fund -- whatever the vehicle(s) you choose for it.

Great post, littlechap! Thanks for responding to mine. I agree with most of what you say, but, as a new parent, I am of course concerned and more than a bit nervous about my son's future. I have seen perfectly nice parents who's values are intact raise utter monsters for children (ok, maybe that's a bit harsh!) I fully plan to invest as much time in my son as possible, and to try my utmost to bring him up right, but there is always the possibility that outside influences could prevail. For now, I will go with my 529, and keep my eyes and my options open in the future.

And by the time your kid(s) are 18, I think it will be fairly difficult to get any kind of decent work without four more years of school -- and that message will no doubt be drilled into kids' heads if their educators are doing their jobs.

After everyone has 4 years of college what will seprate them from everyone else. How will one stand apart, the one who has 8 years of school?

After everyone has 4 years of college what will seprate them from everyone else. How will one stand apart, the one who has 8 years of school?

It's not the number of years that matters. It's what goes into the person's head that counts, and the more time you can spend in a focused, intense training environment, the more you learn. Degrees are simply a shorthand way of reporting one's skills to a potential employer. They are not guarantees if intelligence or anything else, but they are a starting point.

So yes, at higher levels of modern corporations, graduate degrees are more and more common. And if the degree actually makes the person better at what they do (that is the idea, obviously!) then the person is going to have better job security just for being more skilled.

Remember, many/most 4-year degrees provide (require) a diversified educational foundation, even though the student concentrates perhaps 25-30% of his/her time in a single major. In my view, the point of a good college education is to round out a young person, to give them a few specific skills, and to teach them how to think critically -- how to analyze new data and continue learning without a classroom around them.

I do not believe that a four-year degree completes an education for a person with any hope of "standing apart" (as the question was phrased). For people who just want to live their lives and get by, I'm sure it's fine. They can continue to be intellectually curious and to develop professionally in other ways. But that is difficult for most folks, I think, and probably will not bring out one's full potential.

Also note that most graduate degrees are highly focused on specific subject areas, or skill sets, or industry types. So the graduate level is where much of today's high-level corporate training happens. Lawyers typically have three years of grad education; MBAs are 2-3 years or more.

I would guess that people leading the exploration for oil or other resources have advanced degrees in geology. Pharmaceutical researchers surely need advanced training. Schoolteachers are often required to get grad degrees before or during their employment, or are offered financial incentives to do so.

Now, the person digging test wells for that geological engineer may not have a degree, and might still make a decent living -- but that work is pretty demanding in other ways. Also, the folks who run experiments for the pharmaceutical guy or wash out the glassware may like working in a laboratory, but they probably don't have the income or the job satisfaction that he does. And so on.

So the amount of education one aspires to depends on one's ambition and salary needs, I suppose. I think there will always be jobs for an honest person who works hard. It will simply be difficult for that person to compete for professional and management jobs, if another hard worker comes along with a bit more training on his/her resume.

I'm sure many big name execs run companies with just baccalaureate degrees or less, but I think if you look at new hires and especially the rising professional class, many will have grad degrees by the time they are hitting their stride and developing a career.

That appears to be a trend, according to the census chart link posted by rad, in reply to this question. On that chart, it shows two columns: perecentage of ALL people over 25 with college degrees; and percentage of people BETWEEN 25 and 34 with college degrees.

In most states, the contrast is stark. In PA, 22.4% of adults have college degrees. But the concentration is much higher (29.1%) among those between 25 and 34. There are similar contrasts in NJ, DE, NY, MD, MA and CT -- the northeast corridor, so to speak.

This part of the country lost a lot of population and business to the Sun Belt, so now it is making big moves from old economic modes into "New Economy" industries based on service and information.

A case history from here in the Keystone State:

A friend took a job at a large local company 10 years ago. Because the company had dominated its market, it had survived lax management and a lot of dead wood on staff. But things were changing, and soon after my friend was employed, the company saw the need for a very quick, decisive move to reduce staff, especially in data processing and related areas.

Well, the memo went out, and was very blunt: the first people cut would be anybody who did not have a four-year degree. And they stuck to that policy, with few exceptions. This helped them winnow down the staff quite a bit, and after that they were more targeted in choosing people for early retirement offers, etc. No doubt there were many people cut who were very talented despite their educational history. But that's how it played out. My friend now has a Master's degree, just in case.

Like I said, that was at least *10 years ago*, so just imagine what it will be like now, or 10 years from now. Competition will be more intense, not less. I think that a person who gets the BA or BS degree today, then sits back and expects that he/she can coast for 40 years, could be in for a rude shock. Just my guess, for what it's worth.

I looked into 529 funds wanting a plan that let me choose varied mutual funds (including international, small cap,...) that were highly rated by Morningstar. I did not want someone else's idea of a generic "aggressive" or "conservative" portfolio. The closest I found was the Virginia plan that uses American Funds mutual funds. The majority in the plan are 4- or 5-star at Morningstar. The big drawback is that (nearly?) all the funds have loads, which I normally never pay. I couldn't decide if the loads were worth it for the favorable tax treatment. Right now my son's college money is in an UTMA and it has some losses carried over from past years, which means that, essentially, the gains until the account is back to break-even (which is coming close) will not give me significant capital gains to tax. When he reaches break-even I will have to decide what to do.

Has anyone else looked carefully at that Virginia plan? Has anyone found any others that match what I'm looking for (maybe some state's new plan)?

I am slightly alarmed at the information presented in this thread, because either i'm missing something real big, or some of what has been said is just plain wrong.

One poster in particular keeps chiming in that the rates of returns on 529 plans are substandard. Lets discuss that for a second ... I believe that most individual investors can not beat the S&P 500. It has been shown that most professional money managers do not beat the S&P 500 once fees and loads are considered. If you consider tax implications it isn't even close (probably not relevant to the discussion at hand). I am not aware of any study which concludes otherwise (please enlighten me if i'm mistaken here).

Several 529 plans offer an S&P index fund as an investment option, or a total market index fund. My 529 (Utah) is based upon Vanguard's index funds which have rock bottom fees. The management fees associated with the state overhead are fairly small. There are bond indexes, stock indexes, international indexes, age-based plans, you name it.

If you believe that managed funds are the way to go, look no further than the American Funds (I think the VA plan...as described by another poster). These funds are top notch in the managed fund world. I own some of these in my 401(k). I probably would just index if I could, but I don't have an index option in my 401(k). If this is your game, you will find options out there that work for you.

Take home message #1 -- some 529's can generate returns that match market indexes which have been shown to outperform most investors.

Take home message #2 -- other 529's also offer managed mutual funds that are highly rated. If you believe that these are the way to go, there are options out there.

OK, another theme in this thread is that 529 plans don't provide the range of investment choices when compared with an IRA or a Coverdale. That is *completely* correct. IRAs and Coverdales are fantastic tools for the trader, someone who actively manages their portfolio, and modferately sophistocated investors. It really ticks me off that 529 plans don't allow for this.

*rant* -- My financial planner tells me that 529's are made this way on purpose by Congress (I haven't confirmed this, but it seems logical, otherwise the marketplace would have created a better 529 solution, and I would have found it). If so, shame on those people for making a tool that is so right in so many ways, but just lacks one key feature -- investment flexibility. Why did they do that? Would it cost more in tax revenue to just make 529's "state sponsored ESAs" with much more contribution flexibility? Did they break them on purpose just to limit their use? Why?

My advice:

Option (1): You are a modferately sophisticated investor, you have moderate income, your retirement accounts are well funded --

Max out a coverdale if you can each year for each child (Some people with high incomes can't contribute to coverdales). Then max out a Roth IRA if you can (some people with high incomes can't contribute, and some people need to stash retirement funds there rather than education funds). I'm not so sure about using a regular IRA (its tax treatment is deferred rather than tax-free), so I won't comment either way on how this stacks up. After you've considered these choices, the next best alternative, in my way of thinking, is the 529. I recommend picking a plan like Utah with small fees and index funds, but there are lots of other options.

Option (2): You invest mostly in actively managed funds because you think they are better for some reason(?), you want the most simple mechanism to save (not lots of accounts):

Go with the 529 from VA or other that matches your actively managed tastes. I don't play this game, but I would recommend you at least look for funds that show long term outperformance of the S&P when fees and loads are considered.

Option (3): You invest mostly in passive (index) funds, you want the most simple mechanism to save, or you can't implement option (1) because your income is too high.

Go with the 529 from Utah (or equivalent), index to your hearts content, and check your statements a few times each year (or less).

Take home message #3 -- I believe that anyone who invests in a 529 with a S&P index fund is making a pretty good choice in the world of planning for future educational needs.

Take home message #4 -- I think that moderately sophisticated investors will find 529 plans confining and they will wish they could do more with them. Still, these make good choices if your income is high enough to eliminate the Coverdale and Roth as options (or if you've maxed those out already).

Another poster brought up the issue of using UGMA/UTMA. I think this is (diplomatically put) sub-optimal. Think of the scenario where the 18 year old decides to vacation in the south of france to *discover themselves* rather than attend college. I'm saving for college for my *1* year old. I have no idea how responsible he's going to be when the time comes. Maybe i'd feel differently if I had a 15 year old bookworm who was totally responsible with only 3 years to go... I think you can do better that this technique.

Take home message #5 -- Keep control of your assets so that you can use them as you see fit to maximize their benefit.

I hope that someone funds this useful in understanding the range of rather imperfect options available. I realize that i'm showing my biases here in many of these choices and I hope that no-one is put off by the way things are presented here.

One poster in particular keeps chiming in that the rates of returns on 529 plans are substandard.

You're talking about me. If you do the homework and check the numbers on plans around the country, your eyes will be opened. These plans have been attracting a lot of negative press, and often for good reason.

I believe that most individual investors can not beat the S&P 500. It has been shown that most professional money managers do not beat the S&P 500 once fees and loads are considered.

Sorry, but IMHO this is old claptrap people use for hiding from the difficulty of managing their own money. I know of many funds that have beaten the S&P over 1, 3 and 5 years (I don't usually bother with 10 or more because 1) I don't it's pertinent anymore and 2) I expect that a smart investor would reallocate within 10 years if necessary.

If you consider tax implications it isn't even close (probably not relevant to the discussion at hand).

What? You pay no taxes on an S&P 500 index fund? Doesn't it have a dividend or cap gains yield between 1 and 2% somewhere? Or are you confusing the issue of index investing with the issue of 529 plans?

I am not aware of any study which concludes otherwise (please enlighten me if i'm mistaken here).

My portfolio concludes otherwise. And no, I'm not sharing.

Several 529 plans offer an S&P index fund as an investment option, or a total market index fund.

Either of which has had a HORRIBLE return over the past 5 years. Just because you did not locate the funds that have been beating the index does not mean they do not exist.

People keep repeating historical reports of the past 50 years and so on. Good grief. New fund managers continuously enter the industry -- with all that past history available as a study guide! So why should we assume that an entire industry will continue to show the same patterns that it has in the past?

Do you have data to prove that tomorrow's fund managers will make all the same errors as yesterday's? No. And the industry has changed a lot since all those old "truisms" were invented. Many managed funds have low fees and low turnover.

The management fees associated with the state overhead are fairly small. There are bond indexes, stock indexes, international indexes, age-based plans, you name it.

Okay, I will name some, tell me if Utah provides them. What if I want an index of strictly Australia and New Zealand equities? I think there *might* be an ETF for that but I do not think Vanguard has a fund for it nor do I know of any 529 plans that offer it, much less allow an investor to allocate a specific weight to it.

Likewise, Japan has had a long rough spell, but it may be attractive again before long. Are there 529 plans that offer Japan-only indexes? And in the meantime, do they offer "Asia ex-Japan" indexes, or things as specific as that? How about Russia or Eastern Europe or China? Can you buy indexes of bond funds in foreign markets, and do those indexes do as well as managed funds in those same regions?

And speaking of bonds... in most 529 plans, you do not have the option of reallocating on the spur of the moment (like, when bonds started going haywire this year) especially if you have just reallocated on the account's anniversary date, or some other such restriction.

If you believe that managed funds are the way to go, look no further than the American Funds

You have just contradicted everything you said above. Is every single fund offered by that company the #1 fund in its category? Hell, no.

I am sorry, but you began your message by talking about how everybody else was wrong (and spoke largely about stuff I said). Well, I take great exception to people who respond to generalizations (like I made about 529 plans) with their own generalizations -- and claim to be reaching some higher level of precision and accuracy!

Take home message #1 -- some 529's can generate returns that match market indexes which have been shown to outperform most investors.

"Take home message?" Could you fit any more condescension in there?

OK, another theme in this thread is that 529 plans don't provide the range of investment choices when compared with an IRA or a Coverdale.

In the interest of accuracy, it is spelled COVERDELL.

*rant* -- My financial planner tells me that 529's are made this way on purpose by Congress (I haven't confirmed this, but it seems logical, otherwise the marketplace would have created a better 529 solution, and I would have found it).

There is an entire history of how 529 plans came into existence. If I recall correctly, it was by creative exploitation of a loophole in IRS regulations.

But I think you should be addressing your wrath at the current administration, and Congress, for its TOTAL indifference to the quality of education, from preschool all the way up. Forget about 529 plans and all that -- if there were a more appropriate level of public funding, we would not require all the folderol that we're discussing here. But that's probably just fantasy...

...I believe that anyone who invests in a 529 with a S&P index fund is making a pretty good choice in the world of planning for future educational needs.

TOTALLY disagree. I think that is a huge gamble and I do not think that kind of concentrated investing is very wise at all. Neither does Jack Bogle, according to an interview I read recently.

Another poster brought up the issue of using UGMA/UTMA. I think this is (diplomatically put) sub-optimal. Think of the scenario where the 18 year old decides to vacation in the south of france to *discover themselves* rather than attend college.

Have you ever been to the South of France? The Côte d'Azur has a lot to be said for it, and the weather is a lot better than at Harvard. ;-)

Lot of paranoid parents out there, it seems. If they do not trust their kids, or raise them to have reasonable judgment, then they should not waste time reading this thread.

Your overly fearful response overlooks the possibility that the child might be far better off (for example) starting a business of his/her own, rather than going to a traditional college. I have made arguments for the importance of college degrees for people who seek jobs.

But evidently you have not read very much about the criteria that admissions counselors look for nowadays. A student who spends time (and money) traveling for a while -- especially if it is in some kind of self-directed study or other self-examination process -- may in fact get into better schools or even get more financial aid, because he/she might have more interesting things to say on the entrance application essays.

I mean, how can you think you know so much about the future? My thoughts about this topic have centered on two things: maximizing the ROI of one's available investment dollars; and creating a flexible collection of investment vehicles that will help pay for college, but also pay for other things if necessary. Life is full of surprises. Following too close to the taillights of the guy in front of you can very likely lead to a crash.

I'm saving for college for my *1* year old. I have no idea how responsible he's going to be when the time comes. Maybe i'd feel differently if I had a 15 year old bookworm who was totally responsible with only 3 years to go... I think you can do better that this technique.

If you do not trust the child to be "responsible," then why spend money sending him/her to college at all? Are you also going to pick the school, the major, the courses, and the color of the curtains in the dorm room? Jeepers.

Take home message #5

I am getting REALLY tired of this "take home message" crap. Like we're a bunch of naive schoolchildren and you're the teacher? Come on.

Keep control of your assets so that you can use them as you see fit to maximize their benefit.

Wow, sounds like one of the suggestions I made much earlier. I said that one should start one's own IRA, and beyond that limit, just invest the money, and do the best you can with it. Pay whatever taxes as you go and stop worrying about them. And in 18 years, use it for college -- or NOT -- because nobody will care except you and your family.

You won't have been stuck inside a box of somebody else's design, and you can decide later whether your offspring deserves your generosity or not. If not, you've got a bunch of money to spend that has already been taxed. Take a cruise -- maybe go to the South of France...

I hope that someone funds this useful in understanding the range of rather imperfect options available. I realize that i'm showing my biases here in many of these choices and I hope that no-one is put off by the way things are presented here.

Well, you are correct that certain biases are shown but you also "corrected" several things that were not incorrect, and which you actually seem to agree with as it turns out. And you are correct, the presentation was off-putting, but I have a knack for doing that, too. ;-) A lot of ground has been covered, some of it excessively, I think. But it's a hot topic -- the Fool has put this thread on the top page -- so I guess people do care. Like you, I hope they benefit from this.

I haven't posted much on this because I'm getting close to the end of the road - 1 out of college, one a college sophomore and one a high school junior- and because littlechap writes scrolly posts that pretty much express what I think.

529s have been oversold. They were designed as an estate planning tool(which it is pretty good for) and few people are considering the interactions among using 529s, Coverdells, savings bonds, financial aid and the tax credits. If I qualified for the tax credits, I wouldn't look at 529s. If I hadn't had orphaned Coverdells for a year or 2, I wouldn't have looked at them. With the recent changes in dividend and capital gains rates, I probably wouldn't look at them.

For the one 529 I have for my youngest, I have huge concerns about how fast I can get the money when I want a distribution. At one point, the state was doing it as a reimbursement. I can only hope in a couple of years they have it figured out.

Look, I don't want to debate every single line in your reply. You and I aren't going to agree. If you can beat the S&P in your porfolio --- that's great, 529's probably aren't for you.

I can tell you that I have had difficultly beating the S&P over extended time periods (and it isn't because i'm lazy or stupid or haven't tried). I'm confortable in admitting that. You sound pretty sophisticated as an investor (or you like to brag about yourself -- I can't tell which). I believe I addressed that in my post -- 529's probably aren't optimal for you.

Most people out there can't beat the market. I think the data is clear on that subject. Just because you can beat the market doesn't mean that everyone can.

If you think you can beat the market by shifting out of in-and-out of actively managed funds, great. I promise you that most people can't do this, and I believe they will eventually get hurt -- badly.

You asked: "What, you pay no taxes on a S&P Index Fund?...are you confusing...". No, I am not confused, thanks. I mean that tax considerations aren't relevant when you are talking about investing in tax-free accounts. If you consider the additional tax costs of an actively managed fund (due to higher porfolio turnover), the index funds increase their margin of outperformance (by deferring gains for longer periods). This isn't a factor if you are invested in a 529, ESA, or a Roth (but it is a factor if you are invested in a taxable account).

You said: "...you do not have the option of reallocating on the spur of the moment...". That's correct, however most investors can't successfully time the market. If you can, then 529s are not for you. Thats what I meant by "Sophisticated Investor" or "Trader".

You said: "You have just contradicted everything you said above.". This was in reference to my mention of actively managed funds are available too. It may have sounded like that, but it wasn't my intention. I was saying that I believe that indexing is the way to go, but I know that lots of people (like you, apparently) who believe that actively managed funds are better. Since we aren't having this discussion on the Index funds board, I indicated that 529's have actively managed options... if finding low-performing high-cost investments are important to you. (Btw..these are the 529s that you read about in the paper having terrible performance...naturally, i'd avoid these like the plague too.)

In regards to correcting spelling errors and disapproving of my use of "take home message". Well, thanks, I guess. It may be great debate strategy to try to make the other person seem stupid or arrogant. My "take home message" phrase was a way that someone who was skimming a long post could get my essential points in reading 5 or 6 lines of my message. I don't like to waste people's time. This was a long message of a very long thread, and I fear that people are getting the wrong message from most of it.

In regards to your views on raising children to be responsible. Thanks for the tip. Naturally, i'm doing my best. I've rarely met a parent who is so confident --- I wonder if you have young kids (usually adults who are so sure are just about to have kids, but don't have them yet). I used to think I knew what I was talking about too until I learned that we only have a certain degree of control over how things turn out. On the other hand, maybe your children are little angels and reading "the intelligent investor" at the age of 8.

I have several children so i'm pretty sure at least one will go to college. I have neices and nephews that will probably go to college. I'm fairly confident that I can use my 529 funds in accordance with my goals without having to take the 10% penalty. If not, there's always the grandchildren.

I think people are making a big bet on the future with a UGMA. I don't know why people would do that, when they don't need to. If you are in a 529, you have an adequate level of control, in my view.

You seem like a smart guy. Go re-read my original post and look what I recommended for sophisticated investors. These are recommendations for people like you -- go with an ESA (if you can), then Roth or Traditional (if you can and feel comfortable), then a 529.

I should have added: If you are really confident that you can outperform the market in after-tax dollars in a taxable account, when compared to a market matching investment in a tax-free account, by all means -- open a discount brokerage account and get moving. In fact, consider a career change to the financial industry because you are doing something that probably less than 0.1% of the people in the US can do. Hold that thought, if you can do this, you should stop reading now --- you are way out of my league and I don't have any insight that can help you.

I personally have an ESA, 529s, 401(k), and taxable holdings. They all have their place..i'm certainly not recommending using 529s as your only savings/investing option (I didn't think that needed to be said before, but maybe it does).

In conclusion, I stand by my original post. 529s are a good place to stash cash for education purposes for fire-and-forget investors. I think ESAs are better choices, but not everyone can contribute to them and their contribution limits are inadequate (thereby requiring multiple accounts [per kid] if you want to save more).

Regarding 529s, the usual rules apply -- you have to pick a plan that has good investment choices. In my view, these are 529s that have offer low-cost index funds.

Most people out there can't beat the market. I think the data is clear on that subject.

What data? You seem to be referring to the old chestnut that the broad stock market will just go up automatically forever, just because it has done so for decades. This overlooks the fact that parents do not have multiple decades to wait, or that the indexes can be very volatile.

Most people who spew lines like this refer to long time frames, like 25 years or more. Well, here are some changes since 25 years ago:

- AT&T was essentially the only phone company in the U.S.- The IBM PC, MS-DOS, Windows, and the Macintosh did not exist.- There was no European Union; Germany was two separate countries.- The USSR did not allow capitalistic investment.- Three Mile Island and the Chernobyl disaster had not happened yet.- Hong Kong was still British territory, not part of China.- The Vanguard Index 500 fund was one year old

I could go on, but just look at these few things and consider the radical changes that have occurred. Now, ask whether there is any chance for a similarly radical amount of change in the next 25 years.

I say no. I submit that many of the processes can't be repeated. For instance:

1) TECH Profits were increased greatly by the use of data processing technology to eliminate labor-intensive clerical jobs. (See IBM, Windows, Macintosh, etc.) In 2003, there is still room for cost-cutting, but most of the truly massive changes have already happened. Now, the cost of data processing itself is being trimmed -- but profit margins in that sector are slim. Just ask Michael Dell.

2) ENERGY We are highly dependent on energy, as everybody knows, but 25 years ago the nuclear power industry still had a lot of credibility as a way of escaping dependence on foreign oil. But then we faced a potential "China Syndrome" at TMI and we went back to our affair with fossil fuels. (I am not crazy about either nukes or hydrocarbons, but that's another topic.)

The recent blackout smacked us in the face with our lassitude over the past generation or so, during which we've overlooked our infrastructure terribly. If we had spent the money that we should have at the time, maybe the economy would have grown more slowly and all those S&P numbers would be lower. We'll never know. But what about the future?

Well, in coming years, billions should be spent to bring it up to snuff. Assuming that anybody has the political will to do that, it will make energy MORE expensive for at least the next few years, if not longer. Higher energy costs usually mean a drag on the economy, and probably on the stock market.

3) MERGERS In recent years, money has also been made by conglomeration within industry sectors, yielding not only operational efficiencies, but also reducing competition. But how much more is possible? Would the government allow a merger between Pfizer and Merck, or between Verizon and Comcast, or between GM and Ford?

And if such a massive merger were approved, there would have to be a reduction in the resulting labor force. Well, with unemployment at very high levels, could our economy accommodate those layoffs -- or would that instead be unsettling to the broad markets?

4) LIQUIDITY The point is that you can't predict how money will be made in the next 25 years, nor can you predict that the stock market will return to a steady upward trend with any kind of reasonable yield. There was a huge exodus of billions of dollars out of the stock market in recent years, and that money may now be tied up in real estate, bonds, or elsewhere.

In other words, it is conceivable that there isn't enough cash sitting around to fuel a really healthy stock market recovery, due to assets having been committed elsewhere -- including foreign markets. That's one reason I mentioned the major political changes above.

5) WORLD MARKETS Russia and China are two large economies that have opened up in the past 25 years. But -- again -- that's a phenomenon that can't be repeated in the coming 25 years. There are no huge markets of developed nations currently going untapped, that can open up and stimulate new investment the way those two nations have done in recent years.

There will no doubt continue to be new technical innovations, but will they have the economic impact of those that have already occurred -- like the PC, the cell phone, the laptop and PDA, wireless networks, client-server software, and so on? I think that the "big gulps" of investment gain have already been taken, and that we have to think in terms of frequent small sips, as we move forward in such areas.

---

This may seem pretty far afield from the issue of 529 plans, but it is not far afield from your suggestion that an investor can sit back and ride a stock market index into easy wealth. You can't prove that unless you have a crystal ball, and I know you don't. You are making assumptions based on historical data, but I do not think you've looked at the trends beneath that data. That's what I've been discussing here.

I've rarely met a parent who is so confident --- I wonder if you have young kids (usually adults who are so sure are just about to have kids, but don't have them yet).

My personal life is none of your business, and your comments about me and my hypothetical family are pushing the envelope of bad manners. But since you raised the issue, didn't you say that your child is only one year old? It sounds like the words above describe yourself. And if so, how do you claim to be so expert on child-rearing, or to assume that correspondents like me know less than you do? Never mind, it's rhetorical question.

If not, there's always the grandchildren.

What if your child never has kids? On one hand, you say "we only have a certain degree of control over how things turn out" but here you seem to suggest some very strong convictions about what your child will or won't do, in something that should be his/her own personal life decision.

You say that you would just reallocate that 529 money if your kid does not go to college -- but are you really content to go to all that trouble and have the money go elsewhere? I think it would be a little crazy to take tens of thousands of dollars out of one's family nest egg, and make whatever sacrifices that requires -- and end up giving the money to a nephew or a niece! I mean, how is that *really* better than letting one's own child spend the money on a trip to France? It sounds like a moral decison, not a financial one.

Just look at the scandals surrounding amateur sports -- where parents try to play softball, or soccer, or hockey, vicariously through their children. Adults attack each other, even children, all because they have unmet inner needs that they can't face any other way.

Similarly, are we projecting too much of our own desires into this "college" funding topic? Shouldn't we be thinking about the children, and what kinds of life paths they might want to take, and giving them the wherewithal to follow their dreams? I mean, is money a weapon to enforce the parents' will, or is it a resource to broaden the child's horizons -- whether through college, or some other means?

To the extent that I am responsible for another person's future, whether it is via education or something else, I believe I should be as flexible as possible, so that I do not inflict my preconceptions and assumptions on some young adult, somewhere, someday.

If it happens that they start out by going to the South of France, so be it. I can live with that, but I guess you can't. If there is "confidence" involved, as you put it, it is my confidence that Providence will allow every person a second chance -- if needed.

Another person in this thread talked of having squandered a small nest egg after graduating from high school. But that poster went on to succeed nonetheless -- at least, well enough to have money to invest in the next generation's education. Life does not end at 18, or at the first big mistake we make in our lives.

It is for such reasons that I see a simple custodial account as having usefulness in the overall college funding picture. It is fully self-directed, it has tax advantages compared to a parent-owned account (due to lower tax brackets for the child, etc.) and it can be used for multiple purposes, including education. I do not believe it is fair to tell scare stories about children squandering that money, when you do not have an ounce of data on that subject -- just your own fears.

One downside of a UGMA/UTMA is that the minimum investment size in most mutual funds is sizeable -- $2500 to $5000 per fund is not uncommon. By contrast, funds in a Coverdell account can be purchased at the IRA minimum, which is more commonly on the order of $500 or $1000.

So, for the parent who is starting off slowly, it might be necessary to open the custodial account at a firm like Vanguard or Fidelity -- someplace with broad access to multiple families of funds, whether indexed or not; and often with the option of buying in gradually (like, $25 a month or whatever -- I haven't checked that lately). Eventually, when one reaches a certain minimum balance, one can usually move the account to a regular brokerage with a wider range of options, if that seems necessary.

I do not think we disagree on strategies and tools. I think the big difference is that I have more faith in the "average" person to succeed where others have failed. And the reason for that is because they might be here, reading advice, educating themselves, and looking out for pitfalls. If they know that 80% of mutual funds have -- historically -- done worse than the index, they have a choice of buying the index, or simply using all the screening tools out there to locate the "winning" funds, and buy them instead.

You talk about "fire-and-forget investors" -- I submit that NOBODY should fantasize that "fire and forget" is a good way to invest money. Good grief, listen to Jack Bogle. He says very clearly: look at your asset allocation on a regular basis, and adjust as needed. Old Jack doesn't do much more than move back and forth from bonds to stocks, but at least he's watching trends and making changes.

And when I talked about the radical change in the bond market this year, that's a once-in-a-lifetime phenomenon that does not take an Einstein to recognize. I reduced my bond position, slightly belatedly but at least in time to avert even greater losses. And I am not a genius; I just read the paper and listen to CNBC now and then.

It's not all that hard -- and that's all I'd want Joe Average to understand. YES it takes some effort, but if people approach investing the way they approach TV-viewing, just sitting back and goofing off, then they really do deserve to get taken to the cleaners.

Well, I've been lurking for a while and decided to pay my dues and step up to the plate ... so be gentle with me!

I have been following this discussion thread closely. I've learned alot and laughed alot too! While there have been many excellent points made I believe that the following analysis makes the most "quantitative" sense:

The bottom line for me is that here in Texas, the land of no income taxes, a 529 plan with a 0.65% expense ratio will give me the same net result as a taxable mutual fund with a 0.18% expense ratio, only if the mutual fund outgains the 529 by 8%. (I'm not sure that buying individual stocks, while having a lower "expense ratio", would change the results that much ... but I could be wrong, I haven't run the numbers.)

I think the analysis by Ms. Ma could realy support any argument, you just have to pick your poison and hope for the best.

the analysis by Ms. Ma could realy support any argument, you just have to pick your poison and hope for the best.

In fact, Dr. Ma laid out various scenarios, including one in which the state tax rate is high. Readers should keep in mind: if your own state tax rate is low, or if you buy another state's 529 plan, you probably do NOT get the state tax benefit that is described in parts of this study.

Dr. Ma's goal was to examine tax questions separately from performance questions. That makes sense, but the reader should look closely. Her study assumed that every investment vehicle (529, Coverdell, UTMA, or traditional cash account) would be invested in the *same thing*: a stock index fund.

In different scenarios (with/without federal tax changes, with/without state tax benefits, and so on) Dr. Ma finds 529 plans outperforming UGMA/UTMA accounts by various amounts. But this is based only on tax results, with the same mutual funds in the UGMA/UTMA as in the 529.

This only makes sense for the sake of doing an apples-apples comparison of tax consequences. Speaking for myself, I have never argued that one should buy and hold the same exact mutual fund OUTSIDE a 529 plan that one can buy inside a 529 plan. That would be crazy.

What I have said is that I don't like the fund choices available in the 529 plans I've seen. I also chafe at the restrictions some 529s place on the timing or frequency of reallocations, and other things. The greatest transparency and flexibility I've seen were in state plans working with Vanguard, but I still do not feel those plans are set up to handle the changes our economy is going through.

Time may prove me wrong, but we don't know yet. We do know that recent years have not been kind to people holding only the 500 index. By contrast: in a down economy, in a self-directed account you can enter defensive mode (bonds, money market, small cap funds) and still increase the nest egg while the S&P index is plummeting. When/if the economy recovers, you can move the money as you see fit. You can even buy and hold the index if you want. Nothing stops you from doing so.

And how hard is all this? Just read the newspapers and check out CNBC or the like now and then. Personally, I come here to the Fool, and I use Morningstar, as well as other tools provided by my brokers. I just read the summary reports, try to avoid overconcentration -- just basic stuff. A few minutes a day is not much of a cost, considering the payoff.

But I have to speak up when I see people claiming that indexes will go up, while simultaneously claiming that nobody can predict the future for a managed fund. Read that again. People claim that one kind of future is predictable, while another kind of future is not. Hello?

Folks, NONE if this is 100% reliable. There is no foolproof investment. Also, different people have different personalities, and some don't like the anxieties of keeping track of market trends, etc. If a person wants to buy and hold a single investment for 18 years, that's fine for him/her, but I don't think everybody should necessarily follow suit. Likewise, some people like "the hunt" for higher returns, and may take more risk in that process. That, too, is not for everybody.

Back to Dr. Ma: Since her goal was just comparing taxes, she wisely did not muddy the waters by comparing a high-performance managed fund in a UGMA/UTMA custodial account, against an index fund in a 529 account.

But freedom is the main reason to use a custodial account in the first place -- freedom to invest how one wants, and freedom to use the money how one wants. So I believe it remains a viable tool for some investors.

I think the parents' IRA should be considered the first source *IF* the parents can spare the money. Otherwise, an IRA in the child's name is possible if he/she earns money. Those are tax-advantaged AND flexible.

Otherwise, I think the Coverdell is the place to start, mostly because it is tax-advantaged and self-directed.

Yes, some parents will probably do okay with 529 plans, but I expect that they will be parents who benefit the most from a state tax break, who invest in a carefully-chosen plan, and who watch the economy and adjust the asset allocation of the account from time to time.

For those looking for point-and-click convenience, throwing money in a hole and hoping for the best... I would not expect the managers of a typical 529 plan to maximize the potential of that money over 18 years, especially those plans with arbitrary age-based asset allocation. As for 529 "prepaid tuition" plans -- well, those that remain open are under a lot of fire and should be looked at extremely carefully.

With investment-style 529s, always ask whether the plan design favors the needs of the investment company to beef up its less popular funds; or whether the plan really is designed around the needs of the investor. Since 529 plans are still being introduced and modified around the country, this is sort of a moving target. Don't take advice from any one source -- including me! -- but do your homework and you'll be fine.

Yeah, there may seem to be too many options. But for most people this research process should only happen once (when the first child's account is opened). It is not that big a deal, in that perspective.

Yes, it really does. Thank you Littlechap for all your recent efforts in this discussion.

I know some will still not agree with you, and they are certainly entitled to their opinion, but I think you are 100% right. I looked at, and considered a 529 plan, but have decided against it. Mostly for the reasons you cite. I weighed the tax advantages against the disadvantages I saw and for me, giving up control just doesn't seem worth it. Of course, everyone has to weigh that for themselves.

You refer to an UGMA/UTMA account, and to coverdell, but I am not familiar with these, so I'll have to do a little research. But there was just one other idea I wanted to put forth.

In his book The Four Pillars of Investing William Bernstein talks about saving for separate goals, like "retirement? Emergencies? A house? A child's education? The benefit of future generations?" And this is what he has to say about it.

In most cases, you'll be saving and investing simultaneously for several of these things. For example, most young families will likely be saving for all except the last reason. It makes little sense to have separate programs for each, but, rather, to combine all of your goals into one portfolio. Having one overall investment policy for all your assets will greatly simplify your financial management, reduce expenses, and increase your chances of success.

Now, mind you I do not agree with WB on much of what he says in the book regarding indexing. Like you, it seems to me that he is saying on the one hand not to look at past performance when investing for the future, and then he is turning around and doing just that by saying that the index did this and the index did that and of course it will do the same in the future. While I understand his points, it also seems a bit... well, I digress.

It occurs to me that many posters on this board feel that they have to save for college expenses separately from other savings. If I recall your suggestion of using the IRA didn't go over well, but, in fact, I thought that was a very good suggestion.

If I recall your suggestion of using the IRA didn't go over well, but, in fact, I thought that was a very good suggestion.

The main issue I have with using my IRA to fund my child's college expenses are that those funds are earmarked for retirement. If I withdraw the funds to pay for college, they cannot be replenished for retirement. I would be more inclined to take a loan from a 401(k) to pay college expenses as that loan is then repaid into the account.

In addition, it is possible to receive loans to fund a college education but is not practical to receive a loan to fund your retirement.

Yes, that did seem to work quite well for you. However, would you have felt the same way if it was a Roth IRA that would not have been taxed?

I admit it was something I had not really thought of and most likely that is because my children are quite a ways from college and my IRA is not to the point where it will put me in a higher tax bracket in retirement.

Thank you for setting my sites a little further down the road and giving me another thing to consider.

However, would you have felt the same way if it was a Roth IRA that would not have been taxed?

A Roth or Roth conversion has not ever been possible for us so I didn't really think about it. I suppose it might be determined by when I wanted to retire and how much money was where. I would probably use it over a 401K loan because if the 401K person ended up changing jobs or laid off, the loan could become payable or a forced distribution.

Don't forget that at this point in time, retirement money does not get included in the Federal formula for awarding financial aid.

My older kids have Roths because I encouraged them to go in that direction. So far no one has any matching retirement money available but if that occurs, I would encourage them to maximize the match and then fully fund a Roth. With the current tax laws, I might well encourage other retirement money toward a taxable account.

Sorry, I don't have an IRA so I guess I don't understand the concern. I am planning for my DH to retire early and our investments are mostly in a taxable account. The 401k, pension, and ss are just a backup for the later years. And if the college expenses take too much away from the retirement nestegg then we'll just postpone it for a year or two.

Everyone's situation is different. No two people are the same. You wouldn't want to take IRA money for the college costs but that doesn't mean that it's not a perfect solution for someone else.

Everyone's situation is different. No two people are the same. You wouldn't want to take IRA money for the college costs but that doesn't mean that it's not a perfect solution for someone else.

I completely agree that no two situations are the same. Please don't interpret my questions as thinking one approach is better than another. I am still learning and it helps me learn by questioning the opinions of others. Obviously there are reasons why things worked for that person in that situation and that is what I am trying to learn.

As I said in a follow-up to rad's fribble, I had honestly not thought of using the IRA in that fashion for a couple of reasons. However, by the time my kids are of college age, those reasons could very well apply to my situation so it is something I need to add to my considerations.

Thank you for adding to the discussion and I would welcome your opinions on why you think using the IRA is a good idea. This thread has opened my eyes to a lot of things and I am would welcome more opinions and experiences.

But another plan is to put the maximum into your own IRA, because I believe you can withdraw without penalty from your IRA to help fund college tuition. You can't put as much into an IRA, of course, but at least you've got the money socked away either for yourself or the kid, or whatever comes along. If the kid doesn't go to school, you retire a little more comfortably.

The IRA is tax advantaged, yet still allows you to retain control or manage the funds, right? And it's flexible, in that it can be used for either college OR your retirement, either one without penalty.

It seems like this could be a really nice option for parents of very young children who are trying to save for both retirement and college expenses.

Then as rad's fribble points out, if you have too much taxable income in retirement where it bumps you up a bracket, it would be better to use that money for college. Again this is a flexibility issue. The IRA leaves your options open, let's you change plans or switch directions on the fly. Flexible. 529's are not flexible at all.

I think that whenever you are planning for some future event you need all the flexibility you can get because things are liable to change in the blink of an eye. You cannot possibly plan for every single contingency. It's best to keep the plan, the system, as flexible as possible. But that's just my opinion.

I really hate it when the government tries to do me a favor like allowing me to save for my child's college in a tax sheltered account, but then they turn around and put limits here and limits there and take almost all control away from me, and then if I use the funds for something other than I had originally planned... I get penalized and they keep a cut of the loot. What kind of favor is that? No thanks. Because I've learned that some of my best laid plans... often have to be amended.

Anyway, that's why I think using an IRA is a good idea. But, of course, it depends on how far off college is, or retirement for that matter. It depends on your other sources of retirement income, and/or other possible sources of college funds. But if your retirement is going to be so tight that you can't spare the funds from the IRA, then I'd say don't put junior through college. Maybe he needs to start earning his way in life a little sooner than you would like.

...It occurs to me that many posters on this board feel that they have to save for college expenses separately from other savings. If I recall your suggestion of using the IRA didn't go over well, but, in fact, I thought that was a very good suggestion.

Anyway, thanks again for all your input!

You're welcome!

I agree, the ideal (if possible) would be to have all the money come from one single account. An immediate advantage is that it is so much easier to manage total asset allocation, avoid fund overlap that puts too much risk in a single stock or other security, and so on. The "single account" model does not make any assumptions about investment style, either. Being self-directed, it could be all index funds, all managed funds, whatever...

As others will no doubt point out, 529 plans have an advantage for some investors in that they allow large amounts of cash to be tucked away -- far more than an IRA or a Coverdell. But if one only has $2000 a year available, those limits are meaningless. And as you observe, 529 money is segregated, and presents one more group of investments to study and manage apart from one's other investments. It is not unreasonable to want a simpler approach, and a huge IRA (if one could achieve that) would probably be best. It's probably not an option for most folks, though.

To answer your question: UTMA/UGMA are acronyms for "Uniform Transfer (or Gift) to Minors Act" -- some states use one term and some use the other. These laws essentially spell out the terms by which an adult can act as custodian of money that belongs to a person under 18 or 21 (again, the age differing by state).

Point is, since the money belongs to the minor, any taxes are paid at the minor's rate, which is typically the lowest bracket. There are various other rules. In any case, the recent lowering of long-term capital gains tax rates, plus the lower bracket of the child's taxation, means that a custodial account has great tax advantages compared to a straight cash account in a parent's or grandparent's name.

The "downside" is that the gift to the minor is irrevocable. You can't give the money to the child and then take it away. (There are exceptions but not worth discussing here.) Some parents worry about their children being irresponsible with the money once they gain total control over it. Therefore, one understands that a parent might want to avoid putting ALL the education money into such an account.

Which throws the parent back into the idea of splitting money among various vehicles. It's kind of hard to avoid, except for people who have great faith in 529 plans, and are willing to make longterm commitments to them. As you know, I resist the idea for several reasons.

Parents like the 529 because it is earmarked only for education, and may offer some advantages when it comes to applications for scholarships or financial aid. But those "advantages" are really just hypothetical. If the 529 plan administrators invest the money poorly, then all discussion of taxation is moot because you won't pay taxes on a loss in any case. I might not harp on this so much if it weren't for the fact that lost principal has been a real issue for many parents in recent years.

One positive I see in UTMA/UGMA accounts is that the custodian makes all decisions about the investments within them. They also have high limits on the amount that can be deposited -- and above all, the money can apply to any kind of "education" that the child is interested in.

For example, having a nest egg would allow the child to take a low-paying entry level job -- to get one's foot in the door at an employer that has great benefits, for instance -- without having to worry about missing rent payments or whatever. (The goal then should, of course, be to improve one's position and one's pay as fast as possible!)

But here's the kicker: if the money were used for that "non-educational" purpose, the child might very well get ensconced with an employer that has a tuition reimbursement policy -- which means that the company pays for college! A fair number of companies do this, and I know many people who have gotten their degrees that way.

Even if the employer's tuition reimbursement is treated as taxable income (suprisingly, it is not always reported that way!), it still means that the individual attends college for pennies on the dollar.

Sounds great -- but hard or impossible for a parent to "plan" for! So folks try to anticipate various scenarios. As has been said repeatedly: no single approach is "right" for all parents or all kids. That is the main reason to have discussions like this -- to air things out a bit.

Anyway, that's why I think using an IRA is a good idea. But, of course, it depends on how far off college is, or retirement for that matter. It depends on your other sources of retirement income, and/or other possible sources of college funds. But if your retirement is going to be so tight that you can't spare the funds from the IRA, then I'd say don't put junior through college. Maybe he needs to start earning his way in life a little sooner than you would like.

I was drafting a reply to you earlier today but the power went out and work and did not come back on before I decided to leave for the day.

Thank you for posting your reasoning behind the benefits of using an IRA for college expenses. This entire discussion has given me new things to consider as I continue planning for retirement and college expenses.

Sounds great -- but hard or impossible for a parent to "plan" for! So folks try to anticipate various scenarios. As has been said repeatedly: no single approach is "right" for all parents or all kids. That is the main reason to have discussions like this -- to air things out a bit.

You are absolutely correct. Let me be the first to thank all of you that have contributed to this post because it has allowed me to learn new things and look at my savings from viewpoints I had not considered.

It appears obvious that many of you have lived through this first-hand or have a considerable amount of knowledge in this area, and for that I thank you for sharing and contributing.